Busting The Myth Of Oil Storage Hitting 'Tank Tops'

Oil is plentiful. Oil is cheap. Oil is piling up in storage tanks nationwide. America's most famous oil hub, at Cushing, Okla., is already 70% filled, with about 60 million barrels of crude sitting in its tanks.
Total U.S. commercial stocks of crude oil are closing in on 500 million barrels, nearly 150 million barrels above the 5-year average. And storage will get filled up even more. U.S. oil production remains at record highs, as the drastic cuts in drilling and fracking have not yet showed up in lower volumes.

The glut has got America's independent oil companies so freaked out that they are actively agitating for Congress and the Obama Administration to bring an end to the Nixon-era ban on the export of domestic oil. CEOs like Harold Hamm of
Continental Resources and Scott Sheffield of
Pioneer Natural Resources have been front and center explaining that the prices that U.S. producers fetch for their light, sweet crude is in some places $20 less per barrel than what the Saudis get. Yesterday Plains Marketing was paying just $31 a barrel for light oil out of the North Dakota Bakken, while similar oil from the Eagle Ford fetched $44.

"We're exporting every other hydrocarbon," like gasoline, coal, and soon even natural gas in the form of LNG, said Sheffield in Februray. "But we're not exporting oil. So we're trapped."

No doubt it is time to end Richard Nixon's oil export ban.
IHS, in a recent report, found that lifting the export ban could add $26 billion or more a year to GDP and support at least 124,000 jobs. But although the threat of hitting "tank tops" fits smoothly as a key rationale for repealing the ban, it is a rationale based on a shaky foundation.

Because contrary to popular belief there is "plenty of storage, but fear and misperception will likely prevail near term," wrote
Morgan Stanley refining analyst Evan Calio in an in-depth report last week. Calio and his colleagues figure that tank farm utilization will top out near 72% in May at more than 500 million barrels in storage -- high enough to continue supporting bearish sentiment, but not enough to bring about a complete collapse in U.S. crude oil benchmarks.

That's because there's plenty of other holes to stick oil in, they say. "The system is more flexible than most realize. Full storage will never be realized because regional [differentials] move as congestion builds, allowing access to alternative storage, markets and clearing mechanisms."

One aspect of that flexibility is how the storage hub at Cushing, Okla. has changed in recent years. It used to be that Cushing's tanks were more or less land locked. Pipelines ran from the Gulf Coast to Cushing, which largely relied on mid-continent refineries to drain the tanks. But recently big pipelines like the Seaway, Seaway Twin and
TransCanada line have been built or reversed to evacuate more than 1.5 mm bpd more out of Cushing down to the even bigger storage tanks surrounding the Gulf Coast refining megaplex. This wasn't possible in 2012, when Cushing reached its record fill of 88%. "Interconnectivity is better than at any point in the past 5 years," writes Calio.

Samuel Davis, Woodmac's senior manager of refinery asset analysis, agrees, saying last week that there's no way the U.S. will reach "tank tops" because refineries will simply "chew up" the glut, by running their plants at record rates. They are incentivized to do so by refining margins that for some discounted crudes have recently reached $12 per barrel.

Refining margins in the first quarter were the highest refiners have enjoyed in years, notes Credit Suisse analyst Thomas Adolff. This usually happens when the price of oil falls fast while demand for gasoline stays strong, enabling gas stations to keep prices higher for longer. But this "taste of the golden ages," as Adolff puts it, has been bolstered by numerous refinery outages reducing supplies plus extraordinary cold in the Northeast inspiring a surge in consumption.

Already, U.S. refineries are processing in excess of 16 million bpd, says Davis. This is more than 1 million bpd higher than their 5-year average. Furthermore, refiners are moving quickly to add more capacity to process the light, sweet crude coming out of the Permian, Bakken and Eagle Ford. WoodMac sees more than 400,000 bpd of additional processing capacity brought online each year from now through 2018. Projects include a $360 million, 100,000 bpd splitter being built by Kinder Morgan on the Houston Ship Channel, a $400 million plant that Magellan Midstream is building in Corpus Christi, and another that Phillips 66 has planned in Sweeney, Tex.

This will dramatically increase processing capacity for America's own light, sweet, tight oil. Over time this should shrink the discount that U.S. producers have to settle for relative to international crudes. Over time, this could take the wind out of the argument to repeal the export ban.

There's another dynamic at work here: Canadian oil. As I wrote a couple weeks ago, a lot of the crude backing up in Cushing are heavy Canadian barrels, shipped down via the new Flanagan South pipeline. Traders have been happy to store this crude in Cushing to take advantage of the contango situation in the futures markets, whereby the price of oil for delivery six months from now is higher than the current price plus the costs of storing it. Traders are clever. If storage does get tight enough, all those Canadian barrels are capable of being re-exported out of the United States, or at least sent down to the Gulf Coast and loaded onto tankers.

All in all, having too much oil is a pretty good thing for America. Gas prices will stay low. Exports of gasoline and diesel to the rest of the world will increase, helping our balance of payments. And investments will be made that will help the system get even more flexible -- the better to support a continuation of the Great American Oil Boom.